UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark one)

For the quarterly period ended September 30, 2004

OR

For the transition period from                                                          to                                                         

Commission file number 001-07155

R.H. DONNELLEY CORPORATION

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  (X)   No  ( )

Indicate by check mark whether registrant is an accelerated filer  Yes  (X)   No  ( )

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Commission file number 333-59287

R.H. DONNELLEY INC. *

Registrant’s telephone number, including area code (800) 497-6329

*   R.H. Donnelley Inc. is a wholly owned subsidiary of R.H. Donnelley Corporation. R.H. Donnelley Inc. meets the conditions set forth in General Instructions H (1)(a) and (b) of Form 10-Q and is therefore filing this report with respect to R.H. Donnelley Inc. with the reduced disclosure format. R.H. Donnelley Inc. became subject to the filing requirements of Section 15(d) on October 1, 1998 in connection with the public offer and sale of its 9 1/8% Senior Subordinated Notes, which were redeemed in full on February 6, 2004. In addition, R.H. Donnelley Inc. is the obligor of 8 7/8% Senior Notes due 2010 and 10 7/8% Senior Subordinated Notes due 2012 and is subject to the filing requirements of Section 15(d) as a result of such notes. As of November 1, 2004, 100 shares of R.H. Donnelley Inc. common stock, no par value, were outstanding.

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R.H. DONNELLEY CORPORATION

INDEX TO FORM 10-Q

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Part I. FINANCIAL INFORMATION

R.H. Donnelley Corporation and Subsidiaries

The accompanying notes are an integral part of the consolidated financial statements.

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R.H. Donnelley Corporation and Subsidiaries

The accompanying notes are an integral part of the consolidated financial statements.

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R.H. Donnelley Corporation and Subsidiaries

The accompanying notes are an integral part of the consolidated financial statements.

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R.H. Donnelley Corporation and Subsidiaries

The accompanying notes are an integral part of the consolidated financial statements.

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R.H. Donnelley Corporation and Subsidiaries

1. Business and Basis of Presentation

The interim financial statements of R.H. Donnelley Corporation and its direct and indirect wholly owned subsidiaries (the “Company”, “RHD”, “we”, “us” and “our”) have been prepared in accordance with the instructions to Quarterly Report on Form 10-Q and should be read in conjunction with the financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2003. The results of interim periods are not necessarily indicative of results for the full year or any subsequent period. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial position, results of operations and cash flows at the dates and for the periods presented have been included. Certain prior period amounts have been reclassified to conform to the current year’s presentation.

We are a leading yellow pages publisher and directional media company. Directional media is where consumers go to find who sells the goods and services they are ready to purchase. We currently publish 389 yellow pages directories, including 260 Sprint-branded directories in 18 states, with major markets including Las Vegas, Orlando, and Lee County, Florida, with a total distribution of approximately 18 million serving approximately 160,000 local and national advertisers, and 129 SBC-branded directories in Illinois and Northwest Indiana, with a total distribution of approximately 10 million serving approximately 100,000 local and national advertisers. We also offer online city guides and search web sites in our major Sprint markets under the Best Red Yellow Pages brand at www.bestredyp.com and in the Chicago area at www.chicagolandyp.com. We also sell local advertising in Illinois and Northwest Indiana onto www.SMARTpages.com, SBC’s Internet yellow pages platform.

On September 1, 2004, we completed the acquisition of the directory publishing business of SBC Communications, Inc. (“SBC”) in Illinois and Northwest Indiana, including SBC’s interests in The DonTech II Partnership, a 50/50 general partnership between us and SBC (“DonTech”) (collectively, the “SBC Directory Acquisition”), for $1.41 billion in cash, after working capital adjustments and the settlement of a $30 million liquidation preference owed to us related to DonTech. The acquisition was accomplished pursuant to, and in accordance with, the terms of the Purchase Agreement, dated as of July 28, 2004, by and among the Company, Ameritech Corporation (“Ameritech”), a direct wholly owned subsidiary of SBC, and Ameritech Publishing, Inc. (“API”), a direct wholly owned subsidiary of Ameritech. The acquisition was accounted for as a purchase business combination and the purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The results of the SBC Directory Acquisition business are included in our consolidated results from September 1, 2004. The acquired SBC directory business operates as R.H. Donnelley Publishing & Advertising of Illinois Partnership, an indirect wholly owned subsidiary of the Company.

On January 3, 2003, we acquired all the outstanding capital stock of the various entities comprising Sprint Publishing and Advertising (“SPA”), Sprint Corporation’s (“Sprint”) directory publishing business (collectively, the “SPA Acquisition”), for $2.23 billion in cash. The acquisition was accounted for as a purchase business combination and the purchase price was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their respective fair values on the acquisition date. The results of the SPA business are included in our consolidated results from January 3, 2003. The acquired SPA business operates as R.H. Donnelley Publishing & Advertising, Inc., an indirect wholly owned subsidiary of the Company.

2. Summary of Significant Accounting Policies

Principles of Consolidation. The consolidated financial statements include the accounts of R.H. Donnelley Corporation and its direct and indirect wholly owned subsidiaries. All intercompany transactions and balances have been eliminated.

Reclassifications. For 2003, preferred stock dividends of $58.4 million have been reclassified from accumulated deficit to additional paid-in capital.

Revenue Recognition. We earn revenue principally from the sale of advertising into our yellow pages directories. Revenue from the sale of such advertising is deferred when a directory is published and recognized ratably over the life of a directory, which is typically 12 months (the “deferral and amortization method”). Revenue from the sale of

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advertising is recorded net of an allowance for sales claims, estimated based on historical experience on a directory-by-directory basis. We increase or decrease this estimate as information or circumstances indicate that the estimate may no longer adequately represent the amount of claims we may incur for a directory in the future. Before the SBC Directory Acquisition, we also earned revenue from providing pre-press publishing services to SBC for those directories in the DonTech markets. Revenue from these pre-press publishing services was recognized as services were performed.

Deferred Directory Costs. Certain costs directly related to the selling and production of our directories are initially deferred when incurred and recognized ratably over the life of a directory, which is typically 12 months. These costs include sales commissions and print, paper and initial distribution costs. Such costs that are paid prior to directory publication are classified as other current assets.

Equity Method Accounting. Before the SBC Directory Acquisition, DonTech was a 50/50 perpetual partnership in which we and a subsidiary of SBC were the partners. DonTech was a separate legal entity that provided its services with its own employees and a stand-alone management team. The employees of DonTech had the right, authority and power to do any act to accomplish, and enter into any contract incidental to attain, the purposes of the partnership. No employees of either RHD or SBC had been involved in the day-to-day operations of DonTech and, because the partners shared equally in the net profits and each had one voting member on the DonTech board of directors, neither partner had the unilateral ability to control or influence the operations of DonTech. Accordingly, through September 1, 2004, we accounted for DonTech under the equity method and did not consolidate the DonTech results in our financial statements.

Before the SBC Directory Acquisition, we recognized our 50% share of DonTech net income as partnership income in our consolidated statement of operations. DonTech recognized commission revenue based on the annual value of a sales contract in the period the contract was executed (calendar sales) and recognized expenses as incurred. Partnership income also included revenue participation income from SBC. Revenue participation income was based on DonTech advertising sales and was recognized when a sales contract was executed with a customer. Our investment in DonTech and the revenue participation receivable from SBC had been reported as partnership investment on the consolidated balance sheet prior to the SBC Directory Acquisition. Upon the SBC Directory Acquisition, SBC ceased paying us revenue participation income and we no longer recognize our 50% net profits from DonTech. Thus, the DonTech partnership investment was eliminated and, accordingly, commencing on September 1, 2004, we no longer recognize partnership income. Rather the revenues, expenses and income of the acquired directory business are directly recorded in our statement of operations.

Cash and Cash Equivalents. Cash equivalents include liquid investments with a maturity of less than three months at their time of purchase. We place our investments with high quality financial institutions. At times, such investments may be in excess of federally insured limits.

Accounts Receivable. Accounts receivable consist of balances owed to us by our advertising customers. Advertisers typically enter into a 12-month contract for their advertising. Most local advertisers are billed a pro rata amount of their contract value on a monthly basis. On behalf of national advertisers, Certified Marketing Representatives (“CMRs”) typically pay to us the total contract value of their advertising, net of their commission, within 60 days after the publication month. Billed receivables represent the amount that has been billed to advertisers. Unbilled receivables represent contractually owed amounts for published directories that have yet to be billed to advertisers. Billed receivables are recorded net of an allowance for doubtful accounts and sales claims, estimated based on historical experience on a directory-by-directory basis. We increase or decrease this estimate as information or circumstances indicate that the estimate may no longer adequately represent the amount of bad debts and sales claims we may incur.

We have a transition services agreement with SBC whereby SBC bills and collects from our advertising customers in the Illinois and Northwest Indiana directories and remits collections (net of a specified holdback) to us through early 2005. On a monthly basis, SBC purchases the receivables related to those directories from us on a full recourse basis, and as such, we continue to include our portion of the billed and unbilled receivables and any related allowance for doubtful accounts and sales claims on our consolidated balance sheet. We record an advance from SBC that is decreased as SBC collects from our advertisers, thus satisfying that liability. In early 2005, we will buy back all accounts receivable balances from SBC. Thereafter, we will perform all billing and collection functions in house.

Deferred Financing Costs. Certain costs associated with the issuance of debt instruments are capitalized and included in

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other non-current assets on the consolidated balance sheet. These costs are amortized to interest expense over the terms of the respective debt agreements. The bond outstanding method is used to amortize deferred financing costs relating to debt instruments with respect to which we accelerate principal payments. Other deferred financing costs are amortized using the straight-line method. Amortization of deferred financing costs included in interest expense was $3.1 million and $4.6 million for the three months ended September 30, 2004 and 2003, respectively, and $10.2 million and $10.9 million for the nine months ended September 30, 2004 and 2003, respectively.

Advertising Expense. We recognize advertising expenses as incurred. These expenses include public relations, media, on-line advertising and other promotional and sponsorship costs. Total advertising expense was $2.3 million and $1.9 million for the three months ended September 30, 2004 and 2003, respectively, and $8.1 million and $5.7 million for the nine months ended September 30, 2004 and 2003, respectively. Advertising expense for the nine months ended September 30, 2004 includes $1.1 million of advertising costs that pertain to 2003.

Concentration of Credit Risk. Approximately 85% of our directory advertising revenue is derived from the sale of advertising to local small- and medium-sized businesses. These advertisers typically enter into 12-month advertising sales contracts and make monthly payments over the term of the contract. Some advertisers prepay the full amount or a portion of the contract value. Most new advertisers are subject to a credit review. If the advertisers qualify, we may extend credit to them for their advertising purchase. Small- and medium-sized businesses tend to have fewer financial resources and higher failure rates than large businesses. In addition, full collection of delinquent accounts can take an extended period of time and involve significant costs. While we do not believe that extending credit to our local advertisers will have a material adverse effect on our results of operations or financial condition, no assurances can be given. We do not require collateral from our advertisers, although we do charge interest to advertisers that do not pay by specified due dates.

The remaining approximate 15% of our directory advertising revenue is derived from the sale of advertising to national or large regional chains, such as rental car companies, automobile repair shops and pizza delivery businesses. Substantially all of the revenue derived through national accounts is serviced through CMRs with which we contract. CMRs are independent third parties that act as agents for national advertisers. The CMRs are responsible for billing the national customers for their advertising. We receive payment for the value of advertising placed in our directory, net of the CMR’s commission, directly from the CMR. While we are still exposed to credit risk, the amount of losses from these accounts has been historically less than the local accounts as the advertisers, and in some cases the CMRs, tend to be larger companies with greater financial resources than the local advertisers.

At September 30, 2004, we had interest rate swap agreements with major financial institutions with a notional value of $1,355 million, of which $800 million was executed in the third quarter of 2004 primarily as a result of the financing related to the SBC Directory Acquisition. We are exposed to credit risk in the event that one or more of the counterparties to the agreements does not, or cannot, meet their obligation. The notional amount is used to measure interest to be paid or received and does not represent the amount of exposure to credit loss. The loss would be limited to the amount that would have been received, if any, over the remaining life of the swap agreement. The counterparties to the swap agreements are major financial institutions with credit ratings of A or higher. We do not currently foresee a material credit risk associated with these swap agreements; however, no assurances can be given.

Derivative Financial Instruments. We do not use derivative financial instruments for trading or speculative purposes. Our derivative financial instruments are limited to interest rate swap agreements used to manage exposure to fluctuations in interest rates on variable rate debt. These agreements effectively convert $1,355 million of our variable rate debt to fixed rate debt, mitigating our exposure to increases in interest rates. Under the terms of the swap agreements, we receive variable interest based on the three-month LIBOR and pay a weighted average fixed rate of 3.19%. The swaps mature at varying dates beginning October 2005 through September 2009. The weighted average rate received was 1.63% and 1.37% during the three and nine months ended September 30, 2004, respectively. These periodic payments and receipts are recorded as interest expense.

The interest rate swaps have been designated as cash flow hedges to hedge three-month LIBOR-based interest payments on $1,355 million of bank debt. To the extent the swaps provide an effective hedge, changes in the fair value of the swaps are recorded in other comprehensive income, a component of shareholders’ equity. Any ineffectiveness is recorded through earnings. As of September 30, 2004, our interest rate swaps provided an effective hedge of the three-month LIBOR-based interest payments on $1,355 million of bank debt, and no ineffectiveness was included in earnings.

Earnings per Share. In March 2004, the Emerging Issues Task Force (“EITF”) reached a final consensus on EITF

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Issue No. 03-6, Participating Securities and the Two-Class Method under FASB Statement 128 (“EITF 03-6”), which established standards regarding the computation of earnings per share (“EPS”) by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company. EITF 03-6 was effective for interim periods ending June 30, 2004 for calendar year companies. We adopted the provisions of EITF 03-6 during the first quarter of 2004. EITF 03-6 requires earnings available to common shareholders for the period, after deduction of preferred stock dividends, to be allocated between the common and preferred shareholders based on their respective rights to receive dividends. Basic EPS is then calculated by dividing income (loss) allocable to common shareholders by the weighted average number of shares outstanding. EITF 03-6 does not require the presentation of basic and diluted EPS for securities other than common stock; therefore, the following EPS amounts only pertain to our common stock.

Under the guidance of EITF 03-6, diluted EPS are calculated by dividing income (loss) allocable to common shareholders by the weighted average common shares outstanding plus dilutive potential common stock. Potential common stock includes stock options and warrants, the dilutive effect of which is calculated using the treasury stock method, and Preferred Stock, the dilutive effect of which is calculated using the if-converted method. The calculation of basic and diluted EPS for the three and nine months ended September 30, 2004 and 2003 is presented below.

(1)		31,341 / (31,341 + 9,575) for the three months ended September 30, 2004 and 31,208 / (31,208 + 9,575) for the nine months ended September 30, 2004. In computing basic EPS using the two-class method, we have not allocated the loss available to common shareholders in the three and nine months ended September 30, 2003 between common and preferred shareholders since the preferred shareholders do not have a contractual obligation to share in any loss.
(2)		The effect of certain stock options in the three and nine months ended September 30, 2003 and the assumed conversion of the Preferred Stock in the three and nine months ended September 30, 2004 and 2003 were anti-dilutive and therefore are not included in the calculation of diluted EPS.

Employee Stock Options. We follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations in accounting for our stock option plan. Compensation expense related to the issuance of stock options to employees or non-employee directors is only recognized if the exercise price of the stock option is less than the fair market value of the underlying stock at the measurement date.

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Grants were made in October 2002 of 1.5 million options (“Founders Grant”) to certain employees, including senior management, in connection with the SPA Acquisition. These options were granted with an exercise price equal to the fair market value of the Company’s common stock on the measurement date. However, the award of these options was contingent upon the successful closing of the SPA Acquisition. Therefore, these options were subject to forfeiture until January 3, 2003, by which time the fair market value of the Company’s common stock exceeded the exercise price. Accordingly, these options were accounted for as compensatory options, and we are recognizing non-cash compensation expense over the vesting period of the options. We recognized non-cash compensation expense related to these stock options of $0.2 million and $0.3 million in the three months ended September 30, 2004 and 2003, respectively, and $0.8 million and $1.3 million in the nine months ended September 30, 2004 and 2003, respectively.

On July 28, 2004, the Company granted 0.9 million stock appreciation rights (“SARs”) to certain employees, including senior management, in connection with the SBC Directory Acquisition. The SARs were granted with an exercise price equal to the fair market value of the Company’s common stock on the grant date. The maximum appreciation of each SAR is 100% of the initial exercise price. In accordance with APB 25, we recognize non-cash compensation at the end of each period in the amount by which the quoted market value of the underlying shares covered by the grant exceeds the exercise price over the vesting term. We recognized non-cash compensation related to these SARs of $0.2 million during the three and nine months ended September 30, 2004.

The following table reflects the pro forma net income (loss) and earnings (loss) per share for the three and nine months ended September 30, 2004 and 2003 assuming we applied the fair value method of SFAS No. 123, Accounting for Stock-Based Compensation. The pro forma disclosures shown are not necessarily representative of the effects on income and earnings per share in future years.

The pro forma information was determined based on the fair value of stock options calculated using the Black-Scholes option-pricing model with the following assumptions:

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Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and certain expenses and the disclosure of contingent assets and liabilities. Actual results could differ materially from those estimates and assumptions. Estimates and assumptions are used in the determination of sales allowances, allowances for doubtful accounts, depreciation and amortization, employee benefit plans and restructuring reserves, among others.

New Accounting Pronouncements. In March 2004, the EITF reached a final consensus on EITF 03-6 that established standards regarding the computation of EPS by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company. EITF 03-6 was effective for interim periods ending on or after June 30, 2004 for calendar year companies. We adopted the provisions of EITF 03-6 during the first quarter of 2004.

In May 2004, the Financial Accounting Standards Board issued Financial Staff Position (“FSP”) No. FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 for employers that sponsor postretirement healthcare plans that provide drug benefits. The Act introduces prescription drug care benefits under Medicare and also allows for certain sponsors of postretirement benefit plans with a drug benefit to receive a non-taxable federal subsidy if certain criteria are met. The FSP requires interim and annual period financial statements beginning after June 15, 2004 to include the effect of the subsidy on the measurement of net periodic postretirement benefit costs. Pending final guidance on determining actuarial equivalency, the Company has not yet been able to determine the impact of the Act on its postretirement benefit plans. As a result, the accumulated postretirement benefit obligation and net periodic postretirement benefit costs do not yet reflect the effects of the Act.

3. Business Combinations

On September 1, 2004, we completed the SBC Directory Acquisition for $1.41 billion in cash, after working capital adjustments and the settlement of a $30 million liquidation preference owed to us related to DonTech. The fair value of the tangible and identifiable intangible assets acquired and liabilities assumed for the SBC Directory Acquisition was $1.38 billion. As a result of the acquisition, we became the publisher of 129 revenue-generating, SBC-branded yellow pages directories in Illinois and Northwest Indiana. The results of the SBC Directory Acquisition business are included in our consolidated results from and after September 1, 2004.

On January 3, 2003, we completed the SPA Acquisition for $2.23 billion in cash and became the publisher of approximately 260 revenue-generating, Sprint-branded yellow pages directories in 18 states. The results of the SPA business are included in our consolidated results from and after January 3, 2003.

The acquisitions were accounted for as purchase business combinations in accordance with SFAS 141, Business Combinations. Each purchase price was allocated to the related tangible and identifiable intangible assets acquired and liabilities assumed based on their respective estimated fair values on the acquisition dates. Certain long-term intangible assets were identified and recorded at their estimated fair value. Identifiable intangible assets acquired include directory services agreements between the Company and each of Sprint and SBC, respectively, customer relationships and acquired trademarks and trade names. In accordance with SFAS 142, Goodwill and Other Intangible Assets, the fair values of the identifiable intangible assets are being amortized over their estimated useful lives in a manner that best reflects the economic benefits derived from such assets. Goodwill is not amortized but is subject to impairment testing on an annual basis. See Note 4, Intangible Assets and Goodwill, for a further description of our intangible assets and goodwill.

Under purchase accounting rules, we did not assume or record the deferred revenue balance associated with SBC-branded directories of $204.2 million at September 1, 2004 or the deferred revenue balance associated with Sprint-branded directories of $315.9 million at January 3, 2003. These amounts represented revenue that would have been recognized subsequent to each acquisition under the deferral and amortization method had the acquisitions not occurred. Accordingly, we did not and will not record revenue associated with directories that were published prior to each acquisition, as well as directories that were published in the month each acquisition was completed. Although the deferred revenue balances were eliminated, we retained all the rights associated with the collection of amounts due under and contractual obligations under the advertising contracts executed prior to the acquisitions. As a result, the billed and unbilled accounts receivable balances acquired in both acquisitions became assets of the Company. Also under purchase accounting rules, we did not assume or record the deferred directory costs related to those

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directories that were published prior to each acquisition as well as directories that published in the month each acquisition was completed, totaling $175.6 million for SBC-branded directories and $63.3 million for Sprint-branded directories. These costs represented operating expenses that would have been recognized subsequent to the acquisitions under the deferral and amortization method had the acquisitions not occurred. Further, under purchase accounting rules, the remaining $32.1 million of the SBC Directory Acquisition business’s deferred directory costs at September 1, 2004 related to directories that were scheduled to publish subsequent to the acquisition. Under purchase accounting rules, we recorded these costs at their fair value, determined as the estimated billable value of the published directory less the expected costs to complete that directory plus a normal profit margin. The fair value of these costs was determined to be $81.3 million, which is $49.2 million higher than their carrying value of $32.1 million. Accordingly, we recorded $49.2 million of additional deferred directory costs as part of our purchase price allocation, which we refer to as “cost uplift” that will be amortized as expense over the life of the related directories. In connection with the SPA Acquisition, the fair value of such costs was $16.6 million of which $8.3 million represented the cost uplift.

Summarized condensed pro forma information for the three and nine month periods ended September 30, 2004 and 2003 assuming the SBC Directory Acquisition and related financing occurred at the beginning of each period is presented below. This pro forma financial information has been prepared in accordance with Article 11 of Regulation S-X and differs materially from the adjusted pro forma data presented in Item 2 of this Quarterly Report on Form 10-Q in that while this pro forma information also includes the combined SBC Directory Acquisition and Donnelley GAAP results for 2003 and 2004, it does not adjust these results to remove the effects of purchase accounting related to the SPA Acquisition and the SBC Directory Acquisition or certain other items described in Item 2 under the caption “Adjusted Pro Forma Amounts and Other Non-GAAP Measures”.

4. Intangible Assets and Goodwill

As a result of the SBC Directory Acquisition and the SPA Acquisition, certain long-term intangible assets were identified and recorded at their estimated fair value. Amortization expense for intangible assets was $14.6 million and $12.5 million for the three months ended September 30, 2004 and 2003, respectively, and $39.5 million and $37.4 million for the nine months ended September 30, 2004 and 2003, respectively. The acquired long-term intangible assets and their respective book values at September 30, 2004 are shown in the table below.

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Directory services agreements between SBC and the Company include a directory services license agreement, a non-competition agreement, a SMARTpages reseller agreement and a directory publishing listing agreement (collectively, “SBC Directory Services Agreements”) with certain affiliates of SBC. The directory services license agreement designates us as the official and exclusive provider of yellow pages directory services for SBC in Illinois and Northwest Indiana (the “Territory”), grants us the exclusive license to produce, publish and distribute white pages directories in the Territory as SBC’s agent and gives us the exclusive right to use the SBC brand and logo on print directories in the Territory. The non-competition agreement prohibits SBC and it affiliates, with certain limited exceptions, from (1) producing, publishing and distributing yellow and white pages print directories in the Territory, (2) soliciting or selling local or national yellow or white pages advertising for inclusion in such directories, and (3) soliciting or selling local internet yellow pages advertising for certain internet yellow pages directories in the Territory or licensing SBC marks to any third party for that purpose. The SMARTpages reseller agreement gives us the exclusive right to sell local internet yellow pages advertising and the non-exclusive right to sell internet yellow pages advertising with respect to geographies outside the Territory to any advertiser (excluding national advertisers) located inside the Territory onto SBC’s SMARTpages.com platform. The directory publishing listing license agreement gives us the right to purchase and use basic SBC subscriber listing information and updates for the purpose of publishing directories. The SBC Directory Services Agreements (other than the SMARTpages reseller agreement) have initial terms of 50 years, subject to automatic renewal and early termination under specified circumstances. The SMARTpages reseller agreement has a term of 5 years. The fair value of these agreements was determined based on the present value of estimated future cash flows and is being amortized under the straight-line method over the indicated terms.

Directory services agreements between Sprint and the Company include a directory services license agreement, a trademark license agreement and a non-competition agreement (collectively “SPA Directory Services Agreements”) with certain affiliates of Sprint. The directory services license agreement gives us the exclusive right to produce, publish and distribute directories for Sprint in 18 states where Sprint provided local telephone service at the time of the agreement. The trademark license agreement gives us the exclusive right to use certain specified Sprint trademarks, including the Sprint diamond logo, in those markets, and the non-competition agreement prohibits Sprint in those markets from selling local directory advertising, with certain limited exceptions, or producing, publishing and distributing print directories. The SPA Directory Services Agreements have initial terms of 50 years, subject to automatic renewal and early termination under specified circumstances. The fair value of these agreements was determined based on the present value of estimated future cash flows and is being amortized under the straight-line method over 50 years.

The fair values of local and national customer relationships were determined based on the present value of estimated future cash flows and historical attrition rates and are being amortized under an accelerated method that assumes the value derived from customer relationships is greater in the earlier years and steadily declines over time. The weighted average useful life of these relationships is 20 years.

The fair value of acquired trade names was determined based on the “relief from royalty” method, which values the trade names based on the estimated amount that a company would have to pay in an arms length transaction to use these trade names. These assets are being amortized under the straight-line method over 15 years.

The excess purchase price for the SBC Directory Acquisition and the SPA Acquisition over the net tangible and identifiable intangible assets acquired of $204,806 and $97,040, respectively, was recorded as goodwill. Our intercompany net receivables in connection with the SBC Directory Acquisition and the SPA Acquisition of $141,209 and $28,487, respectively, were eliminated and included in goodwill.

While we do not anticipate significant changes to the fair value of net assets acquired, additional information could come to our attention that may require us to revise the purchase price allocation in connection with the SBC Directory Acquisition. In accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but is subject to impairment testing. No impairment losses were recorded during the period.

5. Partnership Income

Before the SBC Directory Acquisition, partnership income included our 50% share of the net profits of DonTech and revenue participation income received directly from SBC, which was based on the value of advertising sales. As a result of the SBC Directory Acquisition, SBC ceased paying us revenue participation income and we no longer recognize our 50% net profits from DonTech. Thus, the DonTech partnership was eliminated and, accordingly,

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commencing on September 1, 2004 we no longer recognize partnership income. Partnership income during the three and nine months ended September 30, 2004 and 2003 consisted of the following:

6. Long-Term Debt

Long-term debt at September 30, 2004 and December 31, 2003 consisted of the following:

In connection with the SBC Directory Acquisition, we amended and restated on September 1, 2004 our Senior Secured Credit Facility (“Credit Facility”), which consists of a $700 million Term Loan A-2, a $1,650 million Term Loan B-2 and a $175 million Revolving Credit Facility (the “Revolver”) for an aggregate facility of $2,525 million. Term Loans A-2 and B-2 require quarterly principal payments. As of September 30, 2004, the outstanding balances of Term Loans A-2 and B-2 were $592.7 million and $1,644.8 million, respectively. As of September 30, 2004, there were $30.3 million in borrowings under the Revolver. There were no borrowings under the Revolver as of December 31, 2003. The Revolver and Term Loan A-2 mature in December 2009, and Term Loan B-2 matures in June 2011. The Credit Facility provides for a new Term Loan C for potential borrowings up to $400 million, such proceeds, if borrowed, to be used to fund acquisitions, for retirement of Notes, and for redemption of, and payment of dividends on, the Preferred Stock, subject to certain limitations. Substantially all of our assets, including the capital stock of our subsidiaries, are pledged to collateralize our obligations under the Credit Facility and the Senior Notes (defined below).

Our Credit Facility bears interest, at our option, at either:

	•		The higher of (i) a base rate as determined by Deutsche Bank Securities Inc., Salomon Smith Barney Inc. or Bear, Stearns & Co. Inc., plus a 1.00% margin on the Revolver and Term Loan A-2 and a 1.25% margin on Term Loan B-2; and (ii) the Federal Funds Effective Rate (as defined) plus 1/2 of 1%, plus a 1.00% margin on the Revolver and Term Loan A-2 and a 1.25% margin on Term Loan B-2; or
	•		LIBOR rate plus a 2.00% margin on the Revolver and Term Loan A-2 and a 2.25% margin on Term Loan B-2. We may elect interest periods of 1, 2, 3, 6, 9 or 12 months for LIBOR borrowings.

The effective interest rate on the Credit Facility, including the interest rate swaps, during the three and nine months ended September 30, 2004 was 4.54% and 4.25%, respectively.

We have also issued $325 million 8 7/8% Senior Notes due 2010 (“Senior Notes”) and $600 million 10 7/8% Subordinated Notes due 2012 (“Subordinated Notes,” and collectively with the Senior Notes, the “Notes”). Interest is paid on the Notes semi-annually on June 15 and December 15. The Senior Notes were secured in conjunction with the restatement of the Credit Facility in connection with the SBC Directory Acquisition.

On February 6, 2004, we redeemed the remaining aggregate principal amount of the 9 1/8 % Senior Subordinated Notes due 2008 totaling $21.2 million at a redemption price of 104.563% of the principal amount thereof, plus accrued and unpaid interest. For the nine months ended September 30, 2004, we recorded interest expense related to these notes of $1.2 million, consisting of a premium over par value paid at redemption of $1.0 million, plus the write-off of $0.2 million of unamortized deferred financing costs.

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7. Redeemable Convertible Preferred Stock and Warrants

We have 10 million shares of preferred stock authorized for issuance. At September 30, 2004 and December 31, 2003, we had 200,604 shares of Preferred Stock outstanding. The Preferred Stock, and any accrued and unpaid dividends, is convertible into common stock at any time at a price of $24.05 and earns a cumulative dividend of 8% compounded quarterly. We cannot pay cash dividends on the Preferred Stock through September 2005, during which time the dividends will accrue. After October 1, 2005, we may pay the Preferred Stock dividends in cash, subject to any limitations under our Credit Facility, or allow it to accrue, at our option. In connection with the issuance of the Preferred Stock, we also issued warrants to purchase 1.65 million shares of our common stock with exercise prices ranging between $26.82 and $28.62, which are exercisable at any time during a five-year term.

We may redeem the Preferred Stock in cash at any time on or after January 3, 2006 if the market price (as defined) of our common stock exceeds 200% of the conversion price for 30 of 45 trading days. The Preferred Stock is redeemable in cash by us at any time on or after January 3, 2013. The Preferred Stock is redeemable in cash at the option of the holder in the event of a change in control (as defined). At September 30, 2004 and December 31, 2003, the redemption value of the Preferred Stock was $230.3 million and $217.0 million, respectively, and at September 30, 2004, the Preferred Stock was convertible into approximately 9.6 million shares of common stock.

The net proceeds received from the issuance of Preferred Stock were allocated to the Preferred Stock, warrants issued along with Preferred Stock and the beneficial conversion feature (“BCF”) of the Preferred Stock based on their relative fair values. The fair value of the Preferred Stock was estimated using the dividend discount method, which determines the fair value based on the discounted cash flows of the security. The BCF is a function of the conversion price of the Preferred Stock, the fair value of the warrants and the fair market value of the underlying common stock on the date of issuance of the preferred stock. In connection with the issuance of our Preferred Stock and each subsequent quarterly dividend date, a BCF was recorded because the fair value of the underlying common stock at the time of issuance of the preferred stock was greater than the conversion price of the Preferred Stock. The BCF is treated as a deemed dividend because the Preferred Stock was convertible into common stock immediately after issuance. The Preferred Stock dividend for the three and nine months ended September 30, 2004 of $5.5 million and $16.2 million, respectively, consisted of the stated 8% dividend of $4.5 million and $13.3 million, respectively, and a BCF of $1.0 million and $2.9 million, respectively. The Preferred Stock dividend for the three and nine months ended September 30, 2003 of $5.1 million and $53.2 million, respectively, consisted of the stated 8% dividend of $4.2 million and $12.2 million, respectively, and a BCF of $0.9 million and $41.0 million, respectively. The BCF recorded in the nine months ended September 30, 2003 was higher than BCF amounts recorded in subsequent periods, reflecting the issuance of the preferred stock and related warrants in January 2003.

8. Restructuring Charge

Following the SPA Acquisition, we consolidated publishing and technology operations, sales offices and administrative personnel and relocated the headquarters functions in Overland Park, Kansas and Purchase, New York to Cary, North Carolina. Approximately 140 people were affected by the relocation of the headquarters functions in Overland Park, Kansas and Purchase, New York, of which 75 have been included in the restructuring reserve. The remaining 65 people have relocated with the Company. In 2003, $9.5 million was charged to earnings primarily representing severance and related costs associated with the consolidation of the publishing and technology operations, sales offices and administrative personnel and the relocation of our headquarters. In the second quarter of 2004, an additional reserve of $0.7 million was recorded representing an adjustment to previous severance and related cost estimates. In the third quarter of 2004, an additional reserve of $0.1 million was recorded representing an adjustment to previous severance cost estimates. Payments of $2.0 million and $6.1 million were made during the three and nine months ended September 30, 2004, respectively, and the remaining costs will be paid in 2004 and 2005. An additional reserve of $2.1 million was recorded during the second quarter of 2004, representing the estimated fair value of the remaining lease payments, net of estimated sub-lease income, on the former headquarters office lease in New York. Payments of $0.2 million and $0.3 million were made with respect to the former headquarters office lease during the three and nine months ended September 30, 2004, respectively, and the remaining payments will be made through 2006.

In 2003, a $2.2 million reserve was recorded, with an offsetting charge to goodwill, representing the closure of the pre-press publishing facility operated by SPA in Tennessee. The reserve represented the remaining lease payments, net of estimated sub-lease income, on the pre-press facility. Payments of $0.2 million and $0.5 million were made

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with respect to the former pre-press publishing facility during the three and nine months ended September 30, 2004, respectively, and the remaining payments will be made through 2012.

The table below shows the activity in our restructuring reserve during the three and nine months ended September 30, 2004.

9. Benefit Plans

Retirement Plans. R. H. Donnelley has a defined benefit pension plan covering substantially all employees with at least one year of service. The benefits to be paid to employees are based on age, years of service and a percentage of total annual compensation. The percentage of compensation allocated to a retirement account ranges from 3.0% to 12.5% depending on age and years of service (“cash balance benefit”). Benefits for certain employees who were participants in the predecessor The Dun & Bradstreet Corporation (“D&B”) defined benefit pension plan are also determined based on the participant’s average compensation and years of service (“final average pay benefit”) and benefits to be paid will equal the greater of the final average pay benefit or the cash balance benefit. Pension costs, on an annual basis, are determined using the projected unit credit actuarial cost method. R.H. Donnelley’s funding policy is to contribute an amount at least equal to the minimum legal funding requirement. No contributions were required to be made in 2003, 2002 or 2001. The underlying pension plan assets are invested in diversified portfolios consisting primarily of equity and debt securities. A measurement date of December 31 is used for the majority of R. H. Donnelley’s plan assets.

R. H. Donnelley also has an unfunded non-qualified defined benefit pension plan, the Pension Benefit Equalization Plan (“PBEP”), which covers senior executives and certain key employees. Benefits are based on years of service and compensation (including compensation not permitted to be taken into account under the previously mentioned defined benefit pension plan).

R. H. Donnelley offers a defined contribution savings plan to substantially all employees and contributes $0.50 for each dollar contributed by a participating employee, up to a maximum of 6% of each participating employee’s salary (including bonus and commissions).

Other Postretirement Benefits. R. H. Donnelley has an unfunded postretirement benefit plan that provides certain healthcare and life insurance benefits to those full-time employees who reach retirement age while working for the Company.

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The net periodic benefit expense of R.H. Donnelley’s pension and postretirement benefit plans for the three and nine months ended September 30, 2004 and 2003 was as follows:

Net pension benefit expense for DonTech’s pension plan was $131 and for DonTech’s postretirement benefit plan was $72 for the three and nine months ended September 30, 2004, which represents the expense since the date of the SBC Directory Acquisition.

We do not expect to make significant cash contributions to the retirement and postretirement benefit plans in 2004.

In May 2004, the Financial Accounting Standards Board issued Financial Staff Position (“FSP”) No. FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, which provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 for employers that sponsor postretirement healthcare plans that provide drug benefits. The Act introduces prescription drug care benefits under Medicare and also allows for certain sponsors of postretirement benefit plans with a drug benefit to receive a non-taxable federal subsidy if certain criteria are met. The FSP requires interim and annual period financial statements beginning after June 15, 2004 to include the effect of the subsidy on the measurement of net periodic postretirement benefit costs. Pending final guidance on determining actuarial equivalency, the Company has not yet been able to determine the impact of the Act on its postretirement benefit plans. As a result, the accumulated postretirement benefit obligation and net periodic postretirement benefit costs do not yet reflect the effects of the Act.

10. Business Segments

We have revised our historical segment reporting to reflect the change in our business that resulted from the SBC Directory Acquisition and to reflect how management now reviews and analyzes the business. Our business of publishing yellow pages directories is now conducted in one reportable operating segment. All pre-press publishing services and other ancillary services previously performed on behalf of others are now performed entirely on behalf of the directories we now publish. As a result of the SBC Directory Acquisition, SBC ceased paying us revenue participation income and we no longer recognize our 50% net profits from DonTech. Thus, the DonTech partnership investment was eliminated and, consequently, partnership income was no longer recognized commencing on September 1, 2004. Accordingly, the previously reported DonTech operating segment is no longer applicable.

11. Litigation

We are involved in various legal proceedings arising in the ordinary course of our business, as well as certain litigation and tax matters described below. We periodically assess our liabilities and contingencies in connection with these matters based upon the latest information available to us. For those matters where it is probable that we

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have incurred a loss and the loss or range of loss can be reasonably estimated, we record reserves in our consolidated financial statements. In other instances, we are unable to make a reasonable estimate of any liability because of the uncertainties related to both the probable outcome and amount or range of loss. As additional information becomes available, we adjust our assessment and estimates of such liabilities accordingly.

Based on our review of the latest information available, we believe our ultimate liability in connection with pending legal proceedings, including the litigation and tax matters described below, will not have a material adverse effect on our results of operations, cash flows or financial position, as described below. No material amounts have been accrued in our financial statements with respect to any of these matters.

In order to understand our potential exposure under the litigation and tax matters described below under the captions “Information Resources, Inc.” and “Tax Matters,” you need to understand the relationship between us and D&B, and certain of our predecessors and affiliates that, through various corporate reorganizations and contractual commitments, have assumed varying degrees of responsibility with respect to such matters.

In November 1996, the company then known as The Dun & Bradstreet Corporation separated through a spin-off (“1996 Distribution”) into three separate public companies: The Dun and Bradstreet Corporation, ACNielsen Corporation (“ACNielsen”), and Cognizant Corporation (“Cognizant”). In June 1998, The Dun & Bradstreet Corporation separated through a spin-off (“1998 Distribution”) into two separate public companies: R.H. Donnelley Corporation (formerly The Dun & Bradstreet Corporation) and a new company that changed its name to The Dun & Bradstreet Corporation. Later in 1998, Cognizant separated through a spin-off (“Cognizant Distribution”) into two separate public companies: IMS Health Incorporated (“IMS”), and Nielsen Media Research, Inc. (“NMR”). In September 2000, The Dun & Bradstreet Corporation separated into two separate public companies: Moody’s Corporation, (“Moody’s”) (formerly The Dun & Bradstreet Corporation), and a new company that changed its name to The Dun & Bradstreet Corporation. As a result of the form of R.H. Donnelley Corporation’s separation from The Dun & Bradstreet Corporation in 1998, we are the corporate successor of and technically the defendant and taxpayer referred to below as D&B with respect to any matter accruing prior to June 30 1998.

Information Resources, Inc.

The following is a description of an antitrust lawsuit filed in 1996 by Information Resources, Inc. (“IRI”). As more fully described below, VNU N.V., a publicly traded Dutch company (“VNU”), and its U.S. subsidiaries VNU, Inc., AC Nielsen, AC Nielsen (US), Inc. (“ACN (US)”), and NMR (collectively, the “VNU Parties”), have assumed exclusive joint and several liability for any judgment or settlement of this antitrust lawsuit. As a result of the indemnity obligation, we do not have any exposure to a judgment or settlement of this lawsuit unless the VNU Parties default on their obligations. In the event of such default, we have contingent liability for this matter as a result of our succeeding to D&B’s liabilities and obligations as part of the 1998 Distribution. In such event, however, under the contractual commitments described below, any such amounts that we might need to pay would be shared equally (50% each) by D&B and Moody’s, on a joint and several basis. Only if D&B and Moody’s were unable to bear all or a part of this liability, would we be liable, and then only to the extent that either of them could not satisfy their joint and several indemnity obligations to us.

In July 1996, IRI filed a complaint, and subsequently amended in 1997, in the United States District Court for the Southern District of New York, naming as defendants D&B (now, the Company, as successor of D&B), A.C. Nielsen Company (a subsidiary of ACNielsen) and IMS (then known as Cognizant), at the time of the filing, all wholly owned subsidiaries of D&B.

The complaint alleges various violations of U.S. antitrust laws under Sections 1 and 2 of the Sherman Antitrust Act. The complaint also alleges a claim of tortious interference with a contract and a claim of tortious interference with a prospective business relationship. These claims relate to the acquisition by defendants of Survey Research Group Limited (“SRG”). IRI alleges SRG violated an alleged agreement with IRI when it agreed to be acquired by the defendants and that the defendants induced SRG to breach that agreement.

IRI’s antitrust claims allege that the defendants developed and implemented a plan to undermine IRI’s ability to compete within the U.S. and foreign markets in North America, Latin America, Asia, Europe and Australia/New Zealand through a series of anti-competitive practices, including: unlawfully tying/bundling services in the markets in which defendants allegedly had monopoly power with services in markets in which ACNielsen competed with IRI; entering into exclusionary contracts with retailers in certain countries to deny IRI’s access to sales data necessary to

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provide retail tracking services or to artificially raise the cost of that data; predatory pricing; acquiring foreign market competitors with the intent of impeding IRI’s efforts to expand; disparaging IRI to financial analysts and clients; and denying IRI access to capital necessary for it to compete.

IRI’s complaint originally sought damages in excess of $350.0 million, which amount IRI sought to treble under antitrust laws. IRI has since revised its allegation of damages to exceed $650.0 million, which IRI also seeks to treble. IRI has filed with the Court the report of its expert who has opined that IRI suffered damages of between $581.6 million and $651.7 million from the defendants’ alleged practices. IRI also seeks punitive damages of an unspecified amount.

In April 2003, the court denied a motion for partial summary judgment by the defendants that sought to dismiss certain of IRI’s claims and granted in part a motion by IRI seeking reconsideration of certain summary judgment rulings the Court had previously made in favor of the defendants. The motion granted by the court concerns IRI’s claims of injuries from defendants’ alleged conduct in certain foreign markets.

Pursuant to a scheduling order entered by the Court on April 8, 2004, discovery ended on November 1, 2004, and trial is scheduled to begin April 18, 2005.

On June 21, 2004, pursuant to a stipulation between IRI and defendants, the Court ordered that certain of IRI’s claims be dismissed with prejudice from the lawsuit, including the claim for tortious interference with the SRG acquisition. We believe that the dismissal of the tortious interference claims also precludes any claim for punitive damages.

In connection with the 1996 Distribution, Cognizant (now NMR), ACNielsen and D&B (now the Company) entered into an Indemnity and Joint Defense Agreement (the “Original JDA”), pursuant to which they agreed to:

	•		allocate potential liabilities that may relate to, arise out of or result from the IRI lawsuit (“IRI Liabilities”); and
	•		conduct a joint defense of such action.

In particular, the Original JDA provided that:

	•		ACNielsen would assume exclusive liability for IRI Liabilities up to a maximum amount to be calculated at such time as such liabilities become payable as a result of a final non-appealable judgment or any settlement permitted under the Original JDA (the “ACN Maximum Amount”); and
	•		D&B and Cognizant would share liability equally for any amounts in excess of the ACN Maximum Amount.

As a result of VNU’s acquisition of ACNielsen in 2001, VNU assumed ACNielsen’s liabilities under the Original JDA and pursuant to the Original JDA would be included with ACNielsen in the computation of the ACN Maximum Amount.

On July 30, 2004, the VNU Parties, the Company, D&B, Moody’s and IMS entered into an Amended and Restated Indemnity and Joint Defense Agreement (the “Amended JDA”).

Pursuant to the Amended JDA, any and all IRI Liabilities incurred by us, D&B, Moody’s or IMS relating to a judgment (even if not final) or any settlement being entered into in the IRI action will be jointly and severally assumed and fully discharged exclusively by the VNU Parties. Under the Amended JDA, the VNU Parties have agreed to, jointly and severally, indemnify us, D&B, Moody’s and IMS from and against all IRI Liabilities to which they become subject. As a result, the concept of “ACN Maximum Amount” which had been used under the Original JDA to cap ACNielsen’s liability for the IRI Liabilities no longer exists, and all such liabilities are the responsibility of the VNU Parties pursuant to the Amended JDA.

In addition, the Amended JDA provides that if it becomes necessary to post any bond pending an appeal of an adverse judgment, then the VNU Parties shall obtain the bond required for the appeal and shall pay the full cost of

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such bond.

In connection with entering into the Amended JDA, the Company, D&B, Moody’s and IMS agreed to amend certain covenants of the Original JDA to provide operational flexibility for ACNielsen going forward. In addition, the Amended JDA includes certain amendments to the covenants of ACNielsen (which, under the Amended JDA, are now also applicable to ACN (US), which we understand holds ACNielsen’s operating assets) which are designed to preserve such parties claim-paying ability and protect the Company, D&B, Moody’s and IMS. Among other covenants, ACNielsen and ACN (US) agreed that neither they nor any of their respective subsidiaries will incur any indebtedness to any affiliated person, except indebtedness which its payment will, after a payment obligation under the Amended JDA comes due, be conditioned on, and subordinated to, the payment and performance of the obligations of such parties under the Amended JDA. VNU has agreed to having a process agent in New York to receive on its behalf service of any process concerning the Amended JDA.

Under the agreements relating to the 1998 Distribution, D&B assumed the defense and agreed to indemnify us against any payments that we may be required to make, including any liabilities arising under the Original JDA, and IRI Liabilities arising from the IRI action itself, and in each case related legal fees. As required by those agreements, Moody’s Corporation, which subsequently separated from D&B in the 2000 Distribution, has agreed to be jointly and severally liable with D&B for the indemnity obligation to us. We understand that D&B and Moody’s have agreed amongst themselves to share equally (50% each) these indemnity obligations to us. Only if D&B and Moody’s were unable to bear all or a part of their aggregate 50% share of the liability in excess of the cap, would we be liable, and then only to the extent that either of them could not satisfy their joint and several indemnity obligations to us.

Because liability for violations of the antitrust laws is joint and several and because the rights and obligations relating to the Amended JDA are based on contractual relationships, the failure of the VNU Parties to fulfill their obligations under the Amended JDA could result in the other parties bearing all or a share of the IRI Liabilities. Joint and several liability for the IRI Liabilities means that even where more than one defendant is determined to have been responsible for an alleged wrongdoing, the plaintiff can collect all or part of the judgment from just one of the defendants. This is true regardless of whatever contractual allocation of responsibility the defendants and any other indemnifying parties may have made, including the allocations described above between the VNU Parties, the Company, D&B, Moody’s and IMS.

Accordingly, and as a result of the allocations of liability described above, in the event the VNU Parties default on their obligations under the Amended JDA, each of D&B and Moody’s will be jointly and severally responsible for the payment of any portion of any judgment or settlement ultimately payable by the Company (which is the defendant in the IRI action), which could be as high as all of the IRI Liabilities.

We are unable to predict the outcome of the IRI litigation or the financial condition of any of the VNU Parties or the other defendants at the time of any such outcome (and hence we cannot estimate their ability to pay the IRI Liabilities pursuant to the Amended JDA or the judgment or settlement in the IRI action). Nonetheless, while we cannot assure you as to the outcome of this matter, management presently believes that the VNU Parties have sufficient financial resources and borrowing capacity to satisfy their obligations under the Amended JDA and, if they default, D&B and Moody’s have sufficient financial resources and borrowing capacity to reimburse us for any payments we may be required to make and related costs we may incur in connection with this matter. Therefore, management presently believes that the ultimate resolution of this matter would not have a material adverse effect on the Company’s results of operations, cash flows or financial condition. Accordingly, no amount in respect of this matter has been accrued in our consolidated financial statements.

Tax Matters

D&B entered into global tax-planning initiatives in the normal course of its business, primarily through tax-free restructurings of both its foreign and domestic operations (collectively, “Legacy Tax Matters”). The IRS is currently disputing certain tax positions taken with respect to the Legacy Tax Matters. The status of these Legacy Tax Matters is summarized below, including the status of the tentative settlements of two of these matters described in our Form 10-Q for the quarter ended June 30, 2004 (“Q2 Form10-Q”).

Pursuant to a series of tax sharing and other agreements (collectively, “Tax Sharing Agreements”) relating to the spin-offs and separations referred to above, IMS and NMR are jointly and severally liable for, and must pay one-half of, and D&B and Moody’s are jointly and severally liable for, and must pay the other half of, any payments over

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$137.0 million for taxes, accrued interest and other amounts resulting from the Legacy Tax Matters summarized below (other than the matter summarized below under “— Amortization and Royalty Expense Deductions/Royalty Income — 1997-2004,” for which D&B and Moody’s, jointly and severally, are solely responsible). D&B, on our behalf, was contractually obligated to pay, and did pay, the first $137.0 million of tax liability in connection with the matter summarized below as “— Utilization of Capital Losses — 1989-1990.”

Under the terms of the 1998 Distribution, D&B agreed to assume the defense and to indemnify us against any tax liability that may be assessed against us and any related costs and expenses that we may incur in connection with any of these Legacy Tax Matters. Also, as required by those agreements, Moody’s has agreed to be jointly and severally liable with D&B for the indemnity obligation to us. Under the terms of certain of the other spin-offs and separations, D&B and Moody’s have, between each other, agreed to be financially responsible for 50% of any potential liabilities that may arise to the extent such potential liabilities are not directly attributable to each party’s respective business operations. Only if D&B and Moody’s were unable to bear all or a part of these liabilities, would we be liable, and then only to the extent that both of them could not satisfy their joint and several indemnity obligations to us.

As we previously reported in our Q2 Form10-Q, we understand that D&B has negotiated with the IRS a tentative settlement of all outstanding issues related to the matters described below under “Utilization of Capital Losses – 1989-1990” (“Capital Losses Matter”) and, with respect to the matters described below under “Royalty Expense Deductions – 1993-1997” (“Royalty Expense Matter”), has negotiated a tentative settlement for tax years 1995 and 1996, which represented the great majority of the probable exposure for the Royalty Expense Matter (collectively, the “Proposed Settlements”). Having achieved the Proposed Settlements, the next step in the resolution process is for the relevant parties and the IRS to negotiate and execute final settlement agreements reflecting the terms of the respective Proposed Settlements, and then for the IRS to tender to the relevant taxpayer parties final settlement agreements. We understand that D&B is presently awaiting receipt of a final settlement agreement from the IRS with respect to the Capital Losses Matter and, as further described below, D&B recently received from the IRS a final settlement agreement with respect to the Royalty Expense Matter. These Proposed Settlements and any proposed final settlement agreements are tentative, and will not bind any of the parties until final settlement agreements are executed.

While we cannot assure you as to the outcome in these Legacy Tax Matters, management presently believes that D&B and Moody’s have sufficient financial resources, borrowing capacity and, where applicable, indemnity rights against IMS and NMR (who succeeded to Cognizant’s indemnity obligations under the Cognizant Distribution) and IMS and NMR in turn have sufficient financial resources and borrowing capacity to satisfy their respective indemnity obligations to D&B and Moody’s, so as to reimburse us for any payments we may be required to make and related costs we may incur in connection with these Legacy Tax Matters. Therefore, management presently believes that the ultimate resolution of these Legacy Tax Matters would not have a material adverse effect on the Company’s results of operations, cash flows or financial condition.

Utilization of Capital Losses – 1989 – 1990 (Proposed Settlement Pending)

In 2000, D&B filed an amended tax return with respect to the utilization of capital losses in 1989 and 1990 in response to a formal IRS notice of adjustment. The amended tax return reflected an additional $561.6 million of tax and interest due. In 2000, D&B paid the IRS approximately $349.3 million and IMS (on behalf of itself and NMR) paid the IRS approximately $212.3 million. We understand that these payments were made under dispute in order to stop additional interest from accruing and that D&B has filed a complaint for a refund in the United States District Court. As noted above, we understand that D&B has reached a Proposed Settlement of this Capital Losses Matter with the IRS and is expecting to receive a final settlement agreement reflecting the terms of such Proposed Settlement. The Proposed Settlement and any final settlement agreement is tentative and non-binding until a definitive settlement agreement is executed. The Proposed Settlement requires that the complaint for a refund be withdrawn and that D&B make an additional payment to the IRS. We understand that D&B expects that the net impact to D&B’s cash flow to settle this matter could be up to $14.0 million (tax, interest, and penalties, net of tax benefits), although we cannot assure you with respect to whether or not this Capital Losses Matter will be finally resolved or when or on what terms.

Royalty Expense Deductions – 1993 – 1997 (Proposed Settlement Pending)

In the second quarter of 2003, D&B received (on our behalf) a proposed notice of deficiency from the IRS with respect to a partnership transaction entered into in 1993. Specifically, the IRS proposed to disallow certain royalty expense deductions claimed by D&B on its 1993 through 1996 tax returns. We understand that D&B estimates that

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the disallowance of the 1993 and 1994 royalty expense deductions would result in a loss to it of approximately $5.0 million in pending tax refunds and that the additional tax liability to it with respect to the disallowance of the 1995 and 1996 royalty expense deductions could be up to approximately $45.5 million (tax, interest and penalties, net of tax benefits).

In addition, and also in the second quarter of 2003, D&B received from the IRS on behalf of the partnership associated with the above transaction a notice of proposed partnership adjustment challenging the tax treatment of certain royalty payments received by the partnership in which D&B was a partner. In that notice, the IRS is seeking to reallocate certain partnership income to D&B. In January and April 2004, D&B received additional IRS notices (similar to those received in the second quarter of 2003) associated with D&B’s remaining interest in the partnership transaction (as described above) for the three months in 1997 for which the entities were partners. The additional tax liability with respect to D&B’s share of this income for the notices received in the second quarter of 2003 and January and April 2004 could be up to $22.5 million (tax, interest and penalties, net of tax benefits). We understand that D&B believes that these positions regarding the partnership are inconsistent with the IRS’ position with respect to the same royalty expense deductions described above. This $22.5 million additional liability would be in addition to the $45.5 million of additional liability related to royalty expense deductions discussed in the previous paragraph.

As noted above, we understand that D&B has reached a Proposed Settlement with the IRS regarding the disallowance of the 1995 and 1996 royalty expense deductions portion of the Royalty Expense Matter. We also understand that during the third quarter of 2004, the IRS tendered to D&B (on our behalf) a final settlement agreement with respect to the Royalty Expense Matter for tax years 1995 and 1996, reflecting the financial terms (but not necessarily reflecting all other terms) set forth in the related Proposed Settlement. The Proposed Settlement and any final settlement agreement is tentative and non-binding until a definitive settlement agreement is executed.

In accordance with the Tax Sharing Agreements, we and D&B sought consent to execute the final settlement agreement for the Royalty Expense Matter for tax years 1995 and 1996 from the relevant parties having financial responsibilities for that matter under the Tax Sharing Agreements (i.e., Moody’s, IMS, NMR and D&B). All such parties consented to the final settlement agreement tendered by the IRS, with the exception of NMR and IMS.

As a result of NMR’s and IMS’s decision not to consent to the Royalty Expense Matter final settlement agreement, on November 1, 2004, D&B informed the IRS that we could not execute the final settlement agreement. On November 3, 2004, the IRS informed D&B that it was withdrawing the final settlement agreement with respect to the Royalty Expense Matter. As a result, we cannot predict at this time whether or not, or when, the parties will be able to conclude negotiations with the IRS with respect to a final settlement agreement regarding the Royalty Expense Matters for tax years 1995 and 1996 on the financial terms and/or other terms set forth in the Proposed Settlement, if at all.

The Tax Sharing Agreements, which govern each of the parties’ rights and obligations under these circumstances, provide (the “Royalty Expense Indemnity & Defense Provisions”) that, a party withholding consent to a proposed settlement shall “continue or initiate further proceedings” with the IRS “at its own expense, and the liability of [the parties previously in control of such proceedings] shall be limited to the liability that would have resulted from the proposed settlement agreement [that was not consented to] (including interest, additions to tax and penalties which have accrued at that time.)” We believe, therefore, as a result of the failure of NMR and IMS to provide their consent, our contingent (assuming each of D&B and Moody’s fail to satisfy their indemnity obligations to us) liability for this Royalty Expense Matter with respect to tax years 1995 and 1996 has been effectively capped at the amounts provided in the final settlement agreement tendered by the IRS. We also believe that in accordance with the Royalty Expense Indemnity & Defense Provisions, NMR and IMS would be jointly and severally liable for any excess amounts above those reflected in the final settlement agreement tendered by the IRS that may ultimately be owing under this Royalty Expense Matter with respect to tax years 1995 and 1996. We understand that D&B estimates that the ultimate resolution of this portion of the Royalty Expense Matter would have a projected net impact to its cash flow of $37.2 million (tax, interest and penalties, net of tax benefits).

IMS has recently alleged various breaches of our and D&B’s obligations under the Tax Sharing Agreements related to D&B’s management and attempted settlement of this matter with the IRS. In addition to “reserving it rights” against us and D&B, IMS has urged NMR (which is in direct contractual privity with us) to:

•

challenge our application of the Royalty Expense Indemnity & Defense Provisions of the Tax Sharing Agreements — specifically that NMR should reject our position that NMR must now lead

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			the defense and that NMR and IMS jointly and severally indemnify us for any financial outcome that is less advantageous to us than the final settlement agreement); and
	o		assert breaches of contract and to terminate the obligations of IMS and NMR to be jointly and severally liable for, and pay, one-half of the liabilities associated with the Legacy Tax Matters as provided under the Tax Sharing Agreements generally.

We and our legal counsel, and we understand D&B and their legal counsel, believe that neither NMR nor IMS have any right or the legal basis to terminate their indemnity obligations under the Tax Sharing Agreements, and that any attempt by them to do so will be found to be without merit, although we cannot assure you with respect to the ultimate outcome of that issue or with respect to the timing of its resolution.

We anticipate commencing arbitration proceedings along with D&B to enforce our respective rights under the Royalty Expense Indemnity & Defense Provisions and other provisions of the Tax Sharing Agreements should the negotiation process required by the Tax Sharing Agreements fail to resolve the parties’ dispute. While we believe that we should prevail in such arbitration, and thereby effectively cap our exposure with respect to the Royalty Expense Matter for tax years 1995 and 1996 at the levels described above, we cannot assure you as to the ultimate outcome of this matter or with respect to the timing of its resolution.

The 1993, 1994, and 1997 royalty expense deduction portions of the Royalty Expense Matter remain pending before the IRS. We understand that D&B estimates that the disallowance of the deductions for those tax years represents an exposure to it of approximately $6.6 million (tax, interest, and penalties, net of tax benefits).

Amortization Expense Deductions – 1997 – 2004

In the fourth quarter of 2003, D&B received (on our behalf) IRS notices of proposed adjustment with respect to a partnership transaction entered into in 1997. In addition, D&B received, on behalf of the partnership, various IRS materials further explaining the examining agent’s position with respect to the activities of the partnership in 1997 and 1998.

In April 2004, D&B received (on our behalf) proposed notices of deficiency from the IRS, proposing adjustments with respect to the same partnership transaction entered into in 1997 described above. The adjustments proposed in the April notices reflect the notices of proposed adjustment and other IRS materials referred to above.

Specifically, the IRS asserted that certain amortization expense deductions claimed by D&B on its 1997 and 1998 tax returns should be disallowed. We understand that D&B estimates that the additional tax liability to it as a result of the disallowance of the 1997 and 1998 amortization deductions and the disallowance of such deductions claimed from 1999 to date could be up to $57.8 million (tax, interest and penalties, net of tax benefits). This transaction is scheduled to expire in 2012 and, unless earlier terminated, based on current interest rates and tax rates, additional tax exposure would increase at a rate of approximately $2.1 million per quarter (including potential penalties) as future amortization expenses are deducted.

In addition, the IRS has asserted that royalty expense deductions, claimed by D&B on its tax returns for 1997 and 1998 for royalties paid to the partnership should be disallowed. The IRS also has asserted that the receipt of these same royalties by the partnership should be reallocated to and reported as royalty income by D&B, including the portions of the royalties that were allocated to third party partners in the partnership, and, thus, included in their taxable income. We understand that D&B believes that the IRS’ stated positions with respect to the treatment of the royalty expense and royalty income are mutually inconsistent, making it unlikely that the IRS will prevail on both of the positions. As a result, we understand that D&B estimates that after taking into account certain other tax benefits resulting from the IRS’ position on the partnership it is unlikely that there will be any additional cash tax payments due in addition to the amounts noted above related to the amortization expense deduction.

In the event the IRS were to prevail on both positions with respect to the royalty expense/income, which D&B believes unlikely, D&B estimates that the additional tax liability to it as a result of the disallowance of the 1997 and 1998 royalty expense deductions, the disallowance of such deductions claimed from 1999 to date and the inclusion of the reallocated royalty income for all relevant years could be up to $139.5 million (tax, interest and penalties, net of tax benefits), which would be in addition to the $57.8 million noted above related to the amortization expense deduction.

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We understand that D&B has filed protests relating to these matters with the IRS Office of Appeals. We understand that during the third quarter of 2004, D&B was informed by the IRS Office of Appeals that this matter was being returned to the Examination Division of the IRS for further development of the issues. We understand that D&B is attempting to resolve these matters at the Appeals phase before proceeding to litigation, if necessary. If D&B were to challenge, at any time, any of these IRS positions for years 1997 and 1998 in U.S. District Court or the U.S. Court of Federal Claims, rather than in U.S. Tax Court, the disputed amounts for each applicable year would need to be paid in advance for the Court to have jurisdiction over the case.

Conclusion

As a result of our assessment of our exposure in these matters relating to our prior relationship with D&B and its former affiliates, especially in light of our indemnity arrangements with D&B and Moody’s (and the VNU Parties with respect to the IRI matter), and their respective financial resources, borrowing capacity and, in the case of certain Legacy Tax Matters, indemnity rights against IMS and NMR, and in turn IMS and NMR’s respective financial resources and borrowing capacity to satisfy their respective indemnity obligations to D&B and Moody’s, no material amounts have been accrued in our consolidated financial statements for any of these D&B-related litigation and tax matters.

Other Matters

We are also involved in other legal proceedings, claims and litigation arising in the ordinary conduct of our business. Although we cannot assure you of any outcome, management presently believes that the outcome of such legal proceedings will not have a material adverse effect on our results of operations or financial condition and no material amounts have been accrued in our consolidated financial statements with respect to these matters.

12. Guarantees

R.H. Donnelley Inc. is a direct wholly owned subsidiary of the Company and the issuer of the Notes. The Company and the direct and indirect wholly owned subsidiaries of R.H. Donnelley Inc. jointly and severally, fully and unconditionally, guarantee these debt instruments. At September 30, 2004, R.H. Donnelley Inc.’s direct wholly owned subsidiaries were R.H. Donnelley Publishing & Advertising, Inc., R.H. Donnelley APIL, Inc., Get Digital Smart.com Inc., R H. Donnelley Publishing & Advertising of Illinois Partnership, DonTech Holdings, LLC., R.H. Donnelley Publishing & Advertising of Illinois Holdings, LLC and DonTech.

As of September 30, 2004, R.H. Donnelley Corporation has issued 200,604 shares of its Preferred Stock. See Note 7, Redeemable Convertible Preferred Stock and Warrants, for a further description of the terms of the Preferred Stock and the related dividend requirements. See Note 11, Litigation, for a description of various legal proceedings in which the Company is involved and related contingencies.

R.H. Donnelley Corporation receives dividends from R.H. Donnelley Inc. for the payment of income taxes and certain other public company matters. Dividends for these items in these periods were not material.

In general, the Company and its subsidiaries are restricted from paying dividends to any third party, and our subsidiaries are restricted from paying dividends, loans or advances to R.H. Donnelley Corporation, with very limited exceptions, under the terms of our Credit Facility. See Note 6, Long-Term Debt, for a further description of our debt instruments.

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R.H. Donnelley Corporation
Consolidating Condensed Balance Sheet
September 30, 2004

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R.H. Donnelley Corporation
Consolidating Condensed Balance Sheet
December 31, 2003

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R.H. Donnelley Corporation
Consolidating Condensed Statement of Operations
For the Three Months Ended September 30, 2004